Enterprise value is a measure used within fundamental analysis to estimate a company’s total value.
It is calculated using the following formula: Market Capitalisation + Total Debt – Cash (or cash equivalents).
All of this information is readily available within the annual report or within the ‘financials’ section on Yahoo Finance for a particular stock. When it comes to debt, cash or cash equivalents, this information will feature within the balance sheet of the company.
When it comes to all debt, it includes both short term and long term debt.
In order to compare the enterprise value of a company with its share price, you simply need to divide the enterprise value by the number of shares outstanding. This would be the enterprise value per share.
Once you know what the enterprise value per share is, you can compare it with the current share price to determine if you should invest in the company or not.
In order to illustrate how enterprise value works, we will use the example of Apple.
Apple inc., as of April 2022, has market capitalisation of $2,600,000,000,000, with total debt of $125,570,000,000 and cash of $62,640,000,000.
So, the enterprise value would be: $2,600,000,000,000 + $125,570,000,000 – $62,640,000,000 =$2,662,930,000,000
Then, we need to divide this number by the total number of shares that Apple has outstanding, which is 16,320,000,000.
Therefore, the enterprise value per share is $2,662,930,000,000/16,320,000,000 =$163.17.
If the current stock price is significantly higher than this amount, then the investor may decide that it is not a worthwhile investment. However, if the stock price is lower than this figure, then they may decide to go ahead and invest.
Although enterprise value is easy to understand and a convenient way to estimate the true value of a company, it is not without its drawbacks.
One flaw of enterprise value is that it is often unknown how companies are using debt. Some firms are very capital intensive and may be using a lot of short-term debt capital to benefit their short-term operations.
This could alter the results of the enterprise value calculation and provide the wrong impression of a company. It may encourage an investor to avoid investing in a company, when the use of debt is actually used to benefit the company.
If the debt used by a company is helping to grow the business, it is a beneficial thing for an investor. Therefore, it is important to use enterprise value in combination with other methods, such as the qualitative approach of developing an understanding of the business model of the firm.
For this reason, enterprise value often depends on what industry the company operates in. So, in order to use enterprise value effectively, investors should compare the enterprise value of stocks that are within the same industry, to identify what is normal and what is not.
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